FUNDING ISSUES ASSOCIATED WITH DEFINED BENEFIT(DB)pension plans continue to dominate pension news. Almost without exception, the stories about these DB plans have been quite gloomy for the past few years.

In the immediate aftermath of the dot-com bust, conventional wisdom suggested that the DB plan funding issues were caused by poor market returns. As time passed, more and more attention has focused on a much bigger problem: low interest rates. As long-term rates have gone down, solvency liabilities have gone up. As a result, the funded position of plans has deteriorated to the point where all plans are forced to cope with challenges posed by low interest rates.

Compounding the problem has been excessive short-term thinking. Too much energy has been directed towards band-aid solutions such as extending amortization periods for solvency deficiencies or reducing plan benefits. These sorts of solutions put too much at risk from both a member and a sponsor perspective. Members risk loss of benefits and companies risk increasing their debt, a problem made worse by low interest rates.

What is needed is a solution that is based upon the reality of pension plans. Before setting out a proposal, it is important to state some assumptions:
• the under-funding problem is driven to a considerable degree by low long-term interest rates;
• private sector and public sector plans, as well as single employer and multi-employer plans, are challenged by the low interest rate environment;
• in Ontario, the provincial government not only has responsibilities for pension plans as a sponsor and a funder, but it also has responsibilities imposed on it through the Pension Benefit Guarantee Fund;
• pension plans need investment opportunities that can be matched against their liabilities; and
• funds are needed for renewal of the public infrastructure.

Given these assumptions, the provincial government should issue a series of “pension bonds” over a number of years. These bonds would have a duration of 30 years and an interest rate of 6.5%. Only pension funds would be permitted to own the bonds and the proceeds raised would be invested in infrastructure projects. By regulation, solvency liabilities for all pension plans would be assessed using the interest rate established for pension bonds.

This approach would ease the funding problems of most pension plans and would provide capital for public infrastructure. Rebuilding the provincial infrastructure would have a positive impact on the economy through the creation of construction jobs and the maintenance of public sector jobs. Pension bonds would also be an attractive investment for pension funds because they would not only be safe, but they would also provide a good rate of return.

THE PROS AND CONS
While the benefit of pension bonds is significant, the burden of these bonds also needs to be assessed. If pension bonds had an interest rate of 6.5%, the cost of borrowing to the province would be about 1.8% higher than a regular Ontario long bond and would add to the public debt. In addition, safeguards would have to be implemented to ensure that no sponsor could take undue advantage through ill-advised contribution holidays. Steps would also have to be taken to give organized labour a significant role in any infrastructure program funded by pension bonds. An infrastructure program whose goal is to facilitate public sector divestments cannot be the aim of this program.

This approach has both strengths and weaknesses. The point, however, is that we need to expand the boundaries for discussion, and options for pension plans, and begin a meaningful debate on funding issues.

Hugh O’Reilly is a partner with Cavalluzzo, Hayes, Shilton, McIntyre and Cornish in Toronto. horeilly@cavalluzzo.com